# WEEK 7 - Portfolio Analysis (NOT YET COMPLETE) Flashcards

1
Q

How do we calculate the expected return on a two asset portfolio?

A

R(bar)P = WaRa +WbRb

```Where:
R(bar)p = Expected return on Portfolio
Ra = Return on Security A
Rb = Return on Security B
Wa = Share of Security A in portfolio
Wb = Share of Security B in portfolio```
2
Q

How do you calculate the standard deviation of a two asset portfolio?

A

σp = Square root of (W2Aσ 2A + w2B σ 2B + 2WaWb COV (RA,RB)

```Where:
σp  = Portfolio Standard Deviation
σA2= Variance of Investment A
σB2 = Variance of Investment B
COV(Ra,Rb) = Covariance of A and B```

SEE EXAMPLE IN NOTES

3
Q

How do we calculate the Covariance of A and B?

A

COV(Ra,Rb) = SIGMA (Ra - R (bar)a) (Rb - R(bar)b)pi

Where:
R(bar)a = Expected Return on A
R(bar)B = Expected Return on B

SEE EXAMPLE IN NOTES

4
Q

How do we calculate the correlation coefficient?

A

P a,b = COV (Ra,Rb) / σa σb

SEE EXAMPLE IN NOTES

5
Q

What is the correlation scale?

A

Ranges from -1.0 to +1.0. The closer r is to +1 or -1, the more closely the two variables are related (Negatively or Positively). If r is close to 0, it means there is no relationship between the variables.

6
Q

What does the degree of risk reduction depend on?

A

the extent of statistical interdependence between the returns of the different investments

the number of securities over which to spread the risk

7
Q

What is the general rule in portfolio theory?

A

Portfolio returns are a weighted average of the expected returns on the individual investment . . .

BUT . . .

Portfolio standard deviation is less than the weighted average risk of the individual investments, except for perfectly positively correlated investments.

8
Q

How can we rewrite the Standard Deviation considering we know about the Covariance?

A

Since we know the COV of A and B

Can rewrite St.Dev as (CHECK NOTES)

9
Q

What is the Efficient Frontier for Portfolio Analysis?

A

Set of optimal portfolios that offer the highest expected return for a defined level of risk or the lowest risk for a given level of expected return.

(SEE GRAPH IN NOTES)

10
Q

What is the Indifference Curve for Portfolio Analysis?

A

Describe investor demand for portfolios based on the trade-off between expected return and risk.
It is a convex curve, meaning upward curving and where it meets the Efficient Frontier there is a match between supply and demand. This spot is called the Optimal Portfolio.

11
Q

How are the varying degrees of risk displayed in the Indifference Curve?`

A

SEE IN NOTES

12
Q

How do you plot the points of a two asset model where both assets are perfectly correlated?

A

It is only possible to create along a straight line between the 2 assets

SEE GRAPH IN NOTES

13
Q

How do you plot the points of a two asset model where both assets are uncorrelated? (+0.00)

A

Only possible to create a two asset portfolio with risk return along a line between either asset.

SEE GRAPH IN NOTES

14
Q

How do you plot the points of a two asset model where both assets are correlated? (+0.5)

A

Only possible to create a two asset portfolio between the first two curves

SEE GRAPH IN NOTES

15
Q

How do you plot the points of a two asset model where both assets are negatively correlated? (-0.5)

A

Possible to create a two asset portfolio with much lower risk than either asset

SEE GRAPH IN NOTES

16
Q

How do you plot the points of a two asset model where both assets are perfectly negative correlated? (-1.0)

A

Possible to create a two asset portfolio with almost no risk

SEE GRAPH IN NOTES

17
Q

What does a three asset portfolio look like?

A

SEE GRAPH IN NOTES

18
Q

What does a Multi-Security Portfolio look like?

A

SEE GRAPH IN NOTES

19
Q

How can we identify if something is or isn’t a diversifiable risk or a Non-diversifiable risk?

A

SEE GRAPH IN NOTES

20
Q

What are the benefits of International Diversification?

A

International shares may provide a lower risk as a percentage of the risk on a single share

21
Q

What does the Capital Market Line look like as a Portfolio?

A

SEE GRAPH IN NOTES

22
Q

What does the Capital Market Line look like as a Portfolio with indifference curves attached?

A

SEE GRAPH IN NOTES

23
Q

What are the problems with Portfolio theory?

A
• Implemented using historic returns- Standard deviations and correlations to aid decision making about future investment
• The volume of Computations for large portfolios can be inhibiting
• The accurate estimation of indifference curves is an elusive goal